How do you say 'bubble' in Mandarin?

Chinese stocks are on fire and banks are lending like there's no tomorrow. Sound familiar? But China needs to remain healthy. The U.S. can't afford for it to slump.

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By Paul R. La Monica, CNNMoney.com editor at large

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NEW YORK (CNNMoney.com) -- Is the Chinese economy in the same state as the American economy was in the summer of 2007? In other words, all pumped up and ready to pop?

If so, it might be time to learn how to say bubble in Mandarin. And that could be bad news for those hoping for a sustainable U.S. recovery.

The Shanghai Composite Index plunged 5% Wednesday, while Hong Kong's Hang Seng dipped nearly 2.4% on growing concerns that China's robust period of growth could soon stall.

The sell-off spilled over to shares of prominent Chinese companies listed in the United States, with sinking shares for firms ranging from oil producers CNOOC (CEO) and China Petroleum and Chemical (SNP) to Internet companies CDC (CHINA) and Baidu.com (BIDU).

China's economy is still growing rapidly. But some eerie similarities to the U.S. economy just before the credit markets started to unravel two years ago are starting to emerge.

Consider this. Before Wednesday's plunge, Chinese stocks had been racing higher -- the Shanghai Composite was up 16% in July alone. Last week, China State Construction Engineering Corp. went public and surged 70% in its first day of trading.

Now think back to July 2007 -- the Dow closed above 14,000 for the first time (it would peak in October).

Talkback: Do you view China as an economic ally for the U.S. or a growing threat? Leave your comments at the bottom of this story.

Just as American banks once were, Chinese banks are being loose with credit.

According to figures from the People's Bank of China, China's central bank, banks made 7.37 trillion yuan ($1.1 trillion) in new loans during the first half this year.

By way of comparison, Chinese banks issued 4.91 trillion yuan in new loans during all of 2008. China's lending target for all of this year had been just 5 trillion yuan.

As such, there are reports that China's top banks may soon impose limits on new loans, which could lead to slower growth in China's economy.

The hefty loan volume is raising the specter of a potential bad loan bust in China, similar to the subprime nightmare that U.S. banks had to endure.

"Lending from Chinese banks was high-powered stimulus, but the risk is that loans are being made in an environment where more of them are likely to go bad," said Andrew Busch, global currency strategist with BMO Capital Markets in Chicago. "Non-performing loans may soar."

Why China matters

Now you might be wondering why this is a problem for the United States to worry about.

Well, China just so happens to be the largest holder of U.S. Treasurys, holding more than $800 billion worth as of the end of May. Busch speculates that if Chinese banks are suddenly hit with a wave of loan losses, China could try and shore up their balance sheets by selling U.S. bonds.

So far, China has continued to be a big buyer of U.S. debt. But Chinese officials have expressed increased signs of frustration about the mounting U.S. debt load.

"The Chinese have been complaining since the beginning of the year about how the U.S is managing its fiscal house. They are very concerned that the U.S is going to issue and issue and issue more Treasury securities," Busch said.

At some point, China may move beyond just threatening talk and actually take action.

A China-led sell-off could cause bond prices to fall and interest rates to shoot higher. That could have disastrous implications on the U.S. economy since higher rates could cripple chances for a sustained recovery.

That's going to make it all the more imperative for U.S. officials -- most notably, Treasury Secretary Timothy Geithner -- to assure China that the United States is not going to dig itself too deep a debt hole. Geithner held talks with Chinese officials in Washington earlier this week about various economic issues.

Both Geithner and Chinese leaders said they are committed to global economic stability. That's a good sign.

"Talks were constructive. The best we could have hoped for is an agreement from China that the U.S. has done what it had to do and that we will get out of a deficit as fast as we can," said Carl Weinberg, chief economist with High Frequency Economics, a research firm based in Valhalla, N.Y.

What's more, Chinese Vice Premier Wang Qishan said that China would try and do more to boost domestic consumption of goods made in China so that it does not have to rely as much on exports to the United States.

That's a good sign since it should help to quash speculation that the United States and China could be headed toward a trade war.

"There were reassurances from China and the U.S. that they don't support protectionism. That would be bad and ugly and hurts everyone. Both are on the same side," Weinberg said.

Still, Busch is worried that the United States may not be able to exert that much pressure on China to do what it can to narrow the trade gap given that China has significant leverage with its Treasury holdings.

That means that the United States may have to put up with even more job losses in manufacturing to keep China happy. And that obviously poses its own problems for the U.S. economy.

"Allowing a large trade partner to be more competitive is in essence telling the manufacturing sector to take a hike. It's doing the opposite to encourage job creation," Weinberg said.

Weinberg argues though that China's threat to sell Treasurys is just a threat and that is not in China's best interests to do something that could lead to a prolonged U.S. economic slump. So he doesn't think the United States needs to appease China.

But at the same time, Weinberg said that it makes more sense for the United States to recognize that China is now a major part of the global economy. So the United States can not afford to have an antagonistic stance towards it.

"The most important thing we are learning is that China is a nation whose interests have to be considered. That's the new reality," he said.

Talkback: Do you view China as an economic ally for the U.S. or a growing threat? To top of page

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